Theoretical Underpinnings

The Triffin World

The deep unhappiness with the prevailing economic order is rooted in:

• persistent overvaluation of the dollar
• asymmetric trade conditions.

Such overvaluation:

• makes U.S. exports less competitive
• makes U.S. imports cheaper
• handicaps American manufacturing

Manufacturing employment declines as factories close. Those local economies subside, many working families are unable to support themselves and become addicted to government handouts or opioids or move to more prosperous locations.

Infrastructure declines as governments no longer service it, and housing and factories lay abandoned. Communities are “blighted.”

According to Autor, Dorn and Hanson (2016), between 600,000 - 1 million U.S. manufacturing jobs disappeared between 2000 and 2011 due to the “China shock” of increased trade with China.

Including broader categories, the jobs displaced by trade during that decade were closer to 2 million.

Even 2 million job losses over a decade represents only 200,000 per year, a fraction of the churn of jobs that occurs every year because of technology, rising and falling firms and sectors, and the economic cycle.

But that logic was flawed in 2 ways:

1. The estimates of job losses due to trade increased over time as new research emerged.

For instance Autor, Dorn and Hanson (2021); the “China shock” was much larger than initially estimated. Plenty of nonmanufacturing jobs which depended on local manufacturing economies were lost as well.

2. Many job losses were concentrated in states and specific towns where alternative employment was not easily available. For these communities, the losses were severe.

The problem is compounded by the reversal of “the end of history” and the return of national security threats.

With no major geopolitical rivals, U.S. leaders believed they could minimize the significance of declining industrial plant.

But with China and Russia as not only trade but security threats, having a robust and well diversified manufacturing sector is of renewed necessity.

If you have no supply chains with which to produce weapons and defense systems, you have no national security.

• As President Trump argued, “if you don’t have steel, you don’t have a country.”

Many economists fail to include such externalities in their analysis

• They are happy to rely on trade partners and allies for such supply chains

But the Trump camp does not share that trust.

Many of America’s allies and partners have significantly larger trade and investment flows with China than they do with America.

Are we so sure we can trust them, if worse comes to worst?

Such problems are compounded by aggressive Chinese espionage.

According to the Wall Street Journal, in September alone:

the FBI said a Chinese state-linked firm hacked 260,000 internet-connected devices, including cameras and routers, in the U.S., Britain, France, Romania, etc. A Congressional probe said Chinese cargo cranes used at U.S. seaports had embedded technology that could allow Beijing to secretly control them.”

Wall Street Journal

The security, espionage and sabotage vulnerability of sensitive imports from China continues to grow.

The persistent overvaluation of the dollar is the key mechanism for trade imbalances.

Why don’t currency markets equilibrate?

This is because there are at least 2 concepts of equilibrium for currencies.

1. International trade models

In trade models, currencies adjust over the long term to balance international trade.

If a country runs a trade surplus for a sustained period, it receives foreign currency for its goods.

It then sells these for its domestic currency.

• This pushes its domestic currency higher until its currency is strong enough that its exports decline and imports increase, balancing trade.

2. Financial Model

Savers select investment alternatives among different nations [rather than selling their foreign currency].

In this equilibrium concept, currencies adjust to make investors indifferent between holding assets in different currencies, on an ex ante risk-adjusted basis.

However, the latter class of models becomes more complicated when a nation’s currency is a reserve asset, as is America’s.

America provides reserve assets to the world.

• And so there is demand for U.S. dollars (USD) and U.S. Treasury securities (USTs) that is not rooted in balancing trade or in optimizing risk-adjusted returns.

These reserve functions:

• facilitate international trade
• provide a vehicle for large pools of savings, often held for policy reasons (e.g. reserve or currency management or sovereign wealth funds) rather than return maximization.

Much of the reserve demand for USDs and USTs is inelastic with respect to economic or investment fundamentals.

Treasurys bought to collateralize trade between Micronesia and Polynesia are bought irrespective of:

• the U.S. trade balance with either
• the latest jobs report
• the relative return of Treasurys vs. German Bunds.

Such phenomena reflect a “Triffin world” after Belgian economist Robert Triffin.

In a Triffin world, reserve assets are a form of global money supply.

The demand for them is a function of global trade and savings, not the domestic trade balance or return characteristics of the reserve nation.

When the reserve country is large relative to the rest of the world, there are no significant externalities imposed on the reserve country from its reserve status.

The distance from the Triffin equilibrium to the trade equilibrium is small.

However, the reserve country can become smaller relative to the rest of the world when global growth exceeds the reserve country’s growth after a long time.

This builds tensions.

The distance between the Triffin equilibrium and the trade equilibrium can be quite large.

Demand for reserve assets leads to significant currency overvaluation with real economic consequences.